Chairman and Managing Director — Should roles be combined or not?

Written by Vivek Avasthi

Tuesday, 09 November 2010 15:01

According to a recent news item, a committee set up by the Securities and Exchange Board of
India (SEBI) is considering a proposal to separate the roles of the Chairman and the Managing
Director (MD) in listed companies, so as to “prevent concentration of management powers in
the hands of one individual”.

This move has drawn a response from Dr U. D. Choubey, Director-General, Standing

Conference of Public Enterprises (SCOPE), who has reportedly said that companies — at least
those in the public sector — are better off with a unified Chairman and Managing Director
(CMD) role. In his view, much more analysis is required before a decision can be taken in this
matter.

This article takes a detailed look at both the alternatives from the point of view of effective
management and governance, and presents a model for understanding the corporate
implications.

Role definition

The Chairman is expected to provide leadership to the Board of Directors, and is responsible for
its composition. His posture is expected to be “reflective”, maintaining a focus on the long term,
rather than on day-to-day activities. He is expected to make sure that the Board sets and
implements the company's direction and strategy effectively.

The MD runs the company's business on a day-to-day basis. He is responsible for ensuring that
the company's strategic plans and operating budgets are aligned with the corporate objectives
set by the Board. He provides leadership to the company, and is accountable to the Board. The
basic argument against combining the roles of the Chairman and the MD/CEO is that it would
lead to a conflict of interest. It would be difficult for the Board of Directors to supervise the
management of the company effectively, if the Chairman (who heads the Board) is also
“management”.

Additionally, day-to-day pressures of running the company may make the incumbent focus more
on the MD's role, at the cost of his (or her) responsibilities as the Chairman. The combined role
also denies the company the benefit of having two senior people at the helm who can bring their
combined wisdom to bear on any issue at hand. Concentration of all powers in the hands of one
person is also a risk.

The argument in favour of combining the roles of the Chairman and the CEO rests essentially
on “simplicity” — that it is a lot more efficient to have just one person at the top to take decisions
and move forward. This option eliminates the potential harmful effects of having two people at
the top who do not necessarily see eye-to-eye, leading to politics and ego clashes. Last, it might
not be practical (or affordable) for smaller companies to have two senior leaders on its rolls.

Global trends

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Chairman and Managing Director — Should roles be combined or not?

Written by Vivek Avasthi

Tuesday, 09 November 2010 15:01

There is no definitive research evidence to show which approach works better. The US is
trending towards separating the two roles, driven primarily by recent governance scandals
involving high-powered CEOs who were also Chairmen of their companies. UK favours
separating the roles. Many European countries (like Germany and The Netherlands) have made
it mandatory by law. In many cases, where the roles remain combined, companies are choosing
to appoint — in addition to various committees — a “lead director” who would coordinate the
annual evaluation of the CEO, and act as a special advisor to the Chairman/CEO. This
approach seeks to address the need for the Board to have an effective supervisory role in
companies that have a CMD in charge. However, this is, at best, a half-measure — since the
Chairman still runs the Board.

This brings us to the key role to be played by the Board of Directors. It is the vital “third
dimension” to this issue, which most pundits seem to ignore when taking positions on whether
the offices of Chairman and CEO should be combined or kept separate.

By definition, the role of the Board is to “direct the affairs of the corporation, but not to manage
them”. The Board is expected to play the lead role in establishing the mission, objectives,
strategy and policies for the company. It is responsible for hiring (and firing) the MD/CEO. It
reviews and approves the use of resources, and is the guardian of shareholder interests.

While this is what is ideally expected of the Board, the reality is different in different companies.
T. L. Wheelen and J. D. Hunger have come up with the concept of the “Board of Directors
Continuum”.

As per this concept, at one end of the spectrum is the “phantom” Board, which does not get
involved at all in the affairs of the company. At the other end is the “catalyst” Board, which plays
a very active role. Such a Board is not afraid to question and evaluate the recommendations
and decisions of the Chairman or the CEO.

Located between these two types is the “minimal review” Board, which reviews issues that
senior management chooses to bring to its attention.

Optimal combination

Making use of this classification, it is clear that a “phantom” or “rubber stamp” Board, combined
with a Chairman who is also the MD, is a risky proposition, especially from the point of view of
governance. In such a case, the fate of the company is heavily dependent on the mettle of a
single individual — the CMD. Where the CMD is a highly capable person, the leadership is
quick and effective; where that is not the case, the results are highly detrimental.

At the other end, a very active “catalyst” Board, working in tandem with a far-sighted Chairman
and a (separate) capable MD / CEO, is likely to provide the most balanced governance and
direction to the company.

Other combinations will lie in between these two extreme positions, in terms of balance and
effectiveness.

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Chairman and Managing Director — Should roles be combined or not?

Written by Vivek Avasthi

Tuesday, 09 November 2010 15:01

Source : The Hindu Business Line

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